Treasury securities

What Are Treasury Securities?

Treasury securities are debt instruments issued by the U.S. Department of the Treasury to finance the federal government's operations. As a core component of fixed-income investments, these securities represent money loaned to the government, which in turn promises to pay back the principal at maturity along with periodic interest payments, except for Treasury bills. Treasury securities are widely regarded as one of the safest investment options due to being backed by the "full faith and credit" of the U.S. government.²⁹ This backing implies a near-zero default risk.

The primary types of marketable Treasury securities include Treasury bills, Treasury notes, and Treasury bonds, distinguished by their original maturity lengths.²⁸ Investors can purchase these securities directly from the U.S. government through TreasuryDirect.gov or via banks and brokers.

History and Origin

The issuance of government debt to finance public expenditures dates back to the very foundation of the United States. The U.S. Department of the Treasury, established in 1789, has historically managed the nation's finances, including the issuance of securities. While various methods of financing government debt have evolved over time, marketable Treasury securities have been a primary tool since the Revolutionary War.²⁷

Initially, debt was often sold through fixed-rate "subscription sales."²⁶ However, the system faced challenges with chronic over-subscription in the late 1920s, indicating that the government was paying too much for its debt. In 1929, the U.S. Treasury transitioned to an auction system for selling Treasury bills, allowing for market-driven pricing. This auction method for selling Treasury marketable securities ensures that the rates reflect actual market demand at the time of issuance.²⁵ Treasury notes and Treasury bonds have regularly been sold at auction since 1974.²⁴

Key Takeaways

• Treasury securities are debt instruments issued by the U.S. government, considered among the safest investments due to their backing by the full faith and credit of the U.S. government.
• They are categorized into Treasury bills (shortest maturity), Treasury notes (intermediate maturity), and Treasury bonds (longest maturity), along with Treasury Inflation-Protected Securities (TIPS).²³
• Treasury securities play a crucial role in the financial markets by providing a stable investment option for individuals, institutions, and foreign governments.²²
• While offering high safety, their yields are typically lower than riskier assets, and they are subject to inflation and interest rate risk.²¹

Formula and Calculation

The calculation of yield varies slightly depending on the type of Treasury security.

For Treasury Bills (T-Bills):
Treasury bills are zero-coupon bonds, meaning they do not pay periodic coupon payments. Instead, they are issued at a discount to their face value and mature at par value. The return comes from the difference between the purchase price and the face value received at maturity.

The Discount Yield for a T-bill is commonly expressed as:

Where:

• Face Value = The par value of the Treasury bill (e.g., $10,000)
• Purchase Price = The price at which the T-bill was bought
• Days to Maturity = The number of days until the T-bill matures

The Investment Yield (or Bond Equivalent Yield) for a T-bill, which allows for better comparison with coupon-paying bonds, is:

This formula uses 365 days for annualization, offering a more precise representation of the return.

For Treasury Notes and Bonds (Coupon-Paying Securities):
For Treasury notes and bonds that pay semi-annual coupon payments, the yield to maturity (YTM) is a more comprehensive measure. This calculation considers the bond's current market price, its face value, its coupon rate, and the time remaining until maturity. The YTM is the total return an investor expects to receive if they hold the bond until it matures, assuming all coupon payments are reinvested at the same rate. Calculating YTM typically requires financial calculators or specialized software due to its iterative nature, solving for (i) in the following formula:²⁰

Where:

• Coupon Payment = Annual coupon rate * Face Value / Number of coupon payments per year
• YTM = Yield to Maturity (the rate we are solving for)
• n = Total number of coupon periods until maturity
• t = The coupon period (from 1 to n)

Interpreting Treasury Securities

Treasury securities serve as a benchmark for risk-free rates in financial markets. Their yield is a key indicator of overall economic health and investor sentiment. When economic uncertainty is high, investors often flock to the safety of Treasury securities, driving up their prices and consequently lowering their yields. Conversely, during periods of strong economic growth and higher inflation expectations, Treasury yields may rise as investors demand greater compensation for holding less risky assets or shift to higher-returning investments.

The maturity of a Treasury security significantly influences its interpretation. Short-term Treasury bills are highly liquid and often used for cash management, reflecting immediate market interest rates. Longer-term Treasury notes and bonds, however, are more sensitive to changes in long-term interest rate expectations and inflation, making their yields critical for understanding long-term borrowing costs and economic outlook. The yield curve, which plots the yields of Treasury securities across different maturities, offers insights into market expectations for future economic growth and inflation.

Hypothetical Example

Consider an investor, Sarah, who wants a low-risk investment for a portion of her savings. She decides to purchase a 5-year Treasury note with a face value of $10,000 and a fixed annual coupon payment of 3%, paid semi-annually.

1. Purchase: Sarah buys the Treasury note at its par value of $10,000.
2. Semi-Annual Payments: Every six months, she receives a coupon payment. Since the annual coupon rate is 3% on a $10,000 face value, the annual interest is $10,000 * 0.03 = $300. Paid semi-annually, each payment is $300 / 2 = $150.
3. Total Payments: Over five years, she will receive 10 semi-annual payments (5 years * 2 payments/year), totaling $150 * 10 = $1,500 in interest.
4. Maturity: At the end of five years, when the Treasury note reaches its maturity, the U.S. government repays the original principal of $10,000 to Sarah.
5. Total Return: In total, Sarah receives $1,500 in interest payments plus her $10,000 principal back, for a total of $11,500 from her initial $10,000 investment. This hypothetical scenario illustrates the predictable income stream and capital preservation offered by Treasury notes.

Practical Applications

Treasury securities are foundational instruments with diverse practical applications across financial markets and investment strategies:

• Capital Preservation and Safety: They are a primary choice for investors seeking to preserve principal due to their minimal default risk.¹⁹ Many institutions, such as pension funds and insurance companies, hold Treasury securities to meet specific liabilities and regulatory requirements.
• Liquidity Management: Their highly liquid secondary market makes them ideal for managing short-term cash flows for businesses and financial institutions.¹⁸
• Portfolio Diversification: Including Treasury securities in a portfolio can help reduce overall portfolio risk, especially during periods of market volatility, due to their typically low correlation with other asset classes like equities.¹⁷ This contributes to effective diversification.
• Benchmark for Interest Rates: Treasury yields serve as a critical benchmark for pricing other financial instruments, including corporate bonds, mortgages, and other loans. Changes in Treasury yields influence borrowing costs throughout the economy.¹⁶ Information on Treasury securities, including their role and types, is also available from investor education resources.¹⁵
• Monetary Policy Implementation: The Federal Reserve uses open market operations, which often involve buying and selling Treasury securities, to influence the money supply and implement monetary policy.

Limitations and Criticisms

While often touted as "risk-free" investments, Treasury securities do carry certain limitations and risks that investors should consider:

• Inflation Risk: The primary risk associated with Treasury securities is inflation risk. If the rate of inflation rises above the bond's yield, the purchasing power of the future interest payments and the repaid principal can erode, leading to a negative real return.¹⁴ This means the investor may receive more dollars back, but those dollars can buy less than when the investment was made.¹³
• Interest Rate Risk: For longer-term Treasury notes and Treasury bonds, changes in market interest rates pose a significant risk. If interest rates rise after a bond is purchased, the market value of existing bonds with lower coupon rates will fall, as new issues offer higher yields. This can lead to capital losses if an investor needs to sell the security before maturity.¹¹, ¹²
• Opportunity Cost: Because of their low default risk, Treasury securities typically offer lower yields compared to other investments like corporate bonds or stocks.⁹, ¹⁰ Investors holding Treasuries might miss out on potentially higher returns available from riskier assets during periods of economic growth. This represents an opportunity cost.
• Limited Income in Low-Yield Environments: In periods of historically low interest rates, the income generated by Treasury securities may be insufficient for investors relying on fixed income.⁸

Treasury Securities vs. Corporate Bonds

Both Treasury securities and corporate bonds are types of debt instruments that represent a loan made by an investor to an issuer in exchange for periodic interest payments and the return of principal at maturity. However, they differ significantly in their issuer, risk profile, and typical yield:

The primary distinction is the issuer's creditworthiness. Treasury securities are considered the safest because the U.S. government can raise money through taxation or by printing currency to fulfill its obligations. Corporate bonds, on the other hand, are subject to the financial health and solvency of the issuing company. During times of economic uncertainty or recession, the spread between corporate bond yields and Treasury yields typically widens as investors demand higher compensation for the increased default risk associated with corporate debt.²

FAQs

Q1: Are Treasury securities truly risk-free?

While commonly referred to as "risk-free" in terms of default risk because the U.S. government has never defaulted on its debt, Treasury securities are not entirely without risk. They are still subject to inflation risk (where purchasing power can be eroded) and interest rate risk (where market value can fluctuate with changing rates).¹

Q2: How do I buy Treasury securities?

Individuals can purchase Treasury bills, Treasury notes, and Treasury bonds directly from the U.S. government through the TreasuryDirect.gov website. They can also be bought through banks, brokers, or investment firms.

Q3: What is the difference between a Treasury bill, note, and bond?

The main difference lies in their maturity periods. Treasury bills have maturities of one year or less and are zero-coupon bonds. Treasury notes have maturities ranging from two to ten years, and Treasury bonds have the longest maturities, typically 20 or 30 years. Notes and bonds pay semi-annual coupon payments.